The Right (And Wrong) Way To Spend Money At Your Startup

0:00When I see founders that are spending too much money, it's because they haven't yet had that light bulb moment with any customers that this is a thing that people want. And so they're kind of chasing that. They're trying to force it. And they think that if they can, the trick is to push harder and not maybe do something different. One of the fundamental misunderstandings that a lot of early stage founders have, and they look at companies that have product market fit. At that point, what you need is growth and money can help buy growth. When you're pre-product market fit, the only goal is to find product market fit and money can't help with that.

0:35The only thing money can buy you pre-product market fit is time.

0:43Welcome to another episode of Office Hours. I'm Brad, and I'm here with Pete, Nikola, and Gustav. And we have sat across the table with thousands of founders over the years talking about all sorts of crazy topics. And today we're going to talk about money and how to think about money, how to think about spending money, when is a good time to spend money, when is a bad time to spend money, what are great things to spend money on, bad things to spend money on, money, money, money. So the startup's kind of relationship to money or maybe the attitude around money changes depending on the stage that the company's at.

1:13And so companies, let's say, that are pre-seed, as one might like to say, where it's day zero, they're just getting started. Maybe they're thinking about applying to Y Combinator or they're just applied to Y Combinator or getting ready. How should they be thinking about money? What's the overall money strategy for a company that early? I think that's pretty simple at that stage. Don't spend$80. Yeah. Like only the very much necessary stuff. Yes, you need the laptop. Yes, you need the place to live. But that's it. If you had to guess, just thinking on the spot here, of all the companies we funded, say in recent years, like how much money have they spent?

1:49What if it's typical? How much money have they actually spent before we funded them? If I think about it, the number is very small. It's very, very small. Sometimes it's zero. Right. It might be tempting to think, oh, there's YC funds companies and they've done all this stuff, but they really haven't. I mean, we fund companies before they even start working on the idea. That's right. That's right. At that point, it's zero. And some people have worked for a while, maybe 10K over six months. And the vast majority don't even have bank accounts yet or even exist as an entity yet. In the earliest stages, you spend no money.

2:19You probably don't have to spend much money on anything. Okay. But then let's say you get out of that and you raise a seed round, anywhere from half a million to$2 million. What are the things that are important for people to be spending money on or that we typically see people spending money on that we think good things. The most common case for software companies, you hire one or maybe two engineers. And that is over a span of 12 months and you know both of them. Okay, let's try to convince the best people. And you already know that they're pretty good. Have you worked with them in the past?

2:48It's even better. Or like you know them from work or some school projects. And then you just kind of get convincing game. You're like convincing them to leave their really other good opportunity. And if you hire those two people, that's mostly what it's all about. For other roles, it's generally like contractors in the early days. You don't really need full-time roles besides one or two more engineers. Founders should be doing sales. Don't have a hire for sales or marketing until product market fit. Yeah, this is kind of one of the dangers of having the money is that the things you don't like doing.

3:19You're like, great, I can hire someone for this. Well, if you don't like doing it, you're probably not very good at it, which means you hire someone who's also not very good at it. So you have to learn the things. And this is another extremely common office hour for us is a founder reaches out, there's this person, they're so good at selling. I think they would be better than me at selling my product that I'm the only one in the world that understands. Help me figure out how to hire them and make them better than I am at selling this. And it's oftentimes a very disappointing office hour for that founder.

3:47We have to say, I'm so sorry. No one is coming to save you. You are on your own. You've got to figure this out. maybe a sales coach sometimes. We've seen some examples of that. Okay. But bringing on someone to sell the product as a seed stage application of money is not good. No one can sell the product better than the founder. True for marketing too, as you can start scaling, like who knows your market? Who knows your customers, your ideal customer profiles? Nobody else than you. It's not because you are going to hire any marketer to do that for you. It's not going to work either. So sales and marketing are the last jobs to hire for.

4:27And to build on that point you gave earlier, like as you are, let's say you raise$2 million and you don't have product market fit, you have nowhere near it, you have maybe a 10K in revenue and you're trying to figure out if there's retention there. The money you have in the bank is the time that you have to hit product market fit. The more people, the slower you get to product market fit. Exactly. Because you become slow, there's a lot of inertia that you have to fight against. Like if you have a big team, then comes the problem of like, and you want to pivot for whatever reason, then you have a whole team to pivot.

4:56Given the time that you have, you can now, first of all, you can try multiple pivots in this time. Yes. And once something is working, you also have multiple chances to fundraise. Normally, I say to people, don't wait until you have maybe 14 or 12 months left and do your first attempt at fundraising or test the waters, maybe. And if it doesn't go well, you have another two shots, actually. And then you can change things and improve things in that time. So the more runway is better. I think oftentimes when I see founders that are spending too much money, It's because they haven't yet had that moment, that light bulb moment with any customers, that this is a thing that people want.

5:29And so they're kind of chasing that. They're trying to force it. They haven't even seen it. Maybe they're first time founders, so they haven't seen it in a previous company either. And they think that if they can, the trick is to push harder and not maybe do something different, or find out more from the customer and let the market kind of pull it out of you. Do you have any tactics on how to be really frugal and disciplined with the money in the bank? I have a few tactics. One of them is to send an investor out please every month because accountability really matters. Having someone else looking at this every month actually forces you to be more accountable.

6:01And the second thing is to have two bank accounts and you put half of the money in the other one, pretend like you don't have it. And then you look at your bank account and be like, oh, I actually only have half the money that I raised. Okay. Let's say you are so fortunate to raise a series A and you found some measure of product market fit. You raised$8 million,$10 million. How are you thinking differently about money now? If you have actual product market fit, actually maybe you should hire sales. I mean that advice may depend on your situation, but let's say you get 1 million AR, you get clear demand from the market, and you are still the only one to sell the product, of course you can create a sales team.

6:37That's a good way to sell the money, as long as you know that anyone you hire is going to be accretive. So basically they're going to make the company more money than you are going to spend on them. If however you have a whatever program, even if you have Series A, like don't buy billboards or don't do some crazy stuff because hey, you are a Series A, you are a serious company now. No, of course not. It's a way to, maybe it's never going to be the right time to do that. Only spend on something you can actually measure the impact of. But hey, hiring some good salespeople, yes, that's a good way.

7:12Yeah, I think you have to have a framework of like, when is each individual person overwhelmed by the inbound that you're experiencing from this thing. So it could be an engineer who can't keep the system up and running. It could be a salesperson who's like, I can't handle all the inbound. It could be customer service. You have to kind of check in and see when are they to the point of breaking. And then you have to have more people. It might often be too late. So you kind of have to have some insight and be like, well, you can't hire someone right away to solve the problem. So you have to kind of like, when do I anticipate based on the directory that these functions in the company is going to be overwhelmed?

7:42And I think that's how I would make my hiring plan. One thing you could do at that stage is to monitor how much revenue you make per employee. And that number should go up in time. So that's another risk. That's maybe another tactic here to be careful about money. You want to be efficient. And the bigger you are, you should get kind of benefit of scale. And so you want that number of revenue per employee to go up. And if you monitor that, that's another good way to avoid the fate of overhiring and then the revenue doesn't catch up. And going back to my advice of sending investors up, there's actually a thing that gets more important to communicate transparently with all your stakeholders or all the people that can keep you accountable.

8:22Because this is the thing where now they have all this money and things are going well, it's like much easier to spend on the wrong things and people actually start paying attention. I would be just a little bit careful. Not all investors are going to tell you the right thing. True, true. Some investors may push you to spend too much. The scenario that I can spend my way to winning is just not generally a thing. Yeah. Well, and it gets at the differing incentives between investors and founders, which is the founder, you have this entity and your job is to make it work and find the best version of it that will work.

8:53Investors make a lot of different bets and build a portfolio of startups and they're looking for the one that's going to work. And so they just operate differently about that. I think one of the mistakes that founders can make in this phase when sales are really starting to work, revenue is growing, is that they don't pay enough attention to retention. If you're going very quickly and you have a lot of revenue coming in, it's easy to ignore your churn. And that's a problem that will catch up with you in a year or two. And at that point, you've spent a whole bunch of money on growth and marketing chasing after bad revenue that's going to disappear.

9:28How should founders, whether seed stage or A or whatever, think about spending money on customer support and customer service? Like, is that in the name of churn reduction? Is that customer experience? Should they not spend anything on there and just hire more programmers? Companies win early stage by being much better at customer support than big companies. So you have to be much better at customer support than big companies. They also serve a point as a handoff from the founders of understanding what the actual pulse of the customer is. What do they like? What feedback are they giving you? And founders play this role for the longest time.

10:04At some point, you can't answer every email, but you should be in every email. You should have a way to peek into the five customer service agents that you have and see what's coming in. Use LM tools to summarize all of the work and see what's coming in there. But they are harder to understand the customer success rule, I think, for a founder, because it's something you do naturally. It's hard for you to find what it is. And to get to your earlier point, I remember when I was running my company, Perfect Audience, there were times when a customer would have a problem. And I would almost be afraid to fix it same day because they would realize how small we were.

10:36Right? I still had this mentality of like, I want to look like a big company. I want to seem big. I need to - We'll put it in the queue. Yeah, we'll put it in the queue. That's like a cooler answer. And we would fix it the same day and good things would happen because of that. But I would always feel this weird emotion like, oh gosh, I just really outed myself as being a little too involved here. But I think that's where the advantage comes. The only edge you have as a startup is speed and responsiveness and all that stuff. Okay, so series A, you might hire for sales, your customer support, you're kind of building the machine that builds the product and takes it to market.

11:16Series B, should you get that far, what is the role of money in a company, series B and beyond? It's different. Once you hit series B, the companies that don't make it are the ones that don't actually understand the quality of their revenue. And the people that have high quality revenue, they'll make it. and things will continue to be good as long as you continue to have good quality of revenue. And the ones that raised a series B, and maybe it was premature, and they don't have enough data to actually look at net dollar retention, revenue, or retention, and customer retention, or whatever usage, they will absolutely have fooled themselves at this point and say, well, there's three different investors in three different rounds that all bet on us and think that this is working.

11:55So it must be working because they have analysts, and they have all these people that analyze our data. But the ones that I've seen who it doesn't work are the ones that don't actually understand their own retention, their own revenue retention. And that can go south. And maybe the investor didn't understand either, actually. Once you hit Series B, if it's actually high quality, you're probably going to do well. By then you should have a revenue engine that you understand and that's predictable. And then the money becomes just fuel in the engine. These engines, I think, are built around an understanding of how a customer goes from being a prospect who's never heard of your product to a customer who's just starting to expanding predictably over the years.

12:37The best SaaS businesses have astronomical net revenue retention because they have figured out how to turn small customers into really big customers. Yes, absolutely. When I think about early stage spending and my own history as a founder, I had these two extremes. There was a lot of time when I was very frugal, sleep on a box on the floor, spend money on nothing. And then I had this other time when I had a split with a co-founder and I was grief stricken by this and just started hiring contractors left and right to work on the product and spent way too much money in grief. And so, you talked earlier about fooling yourself and not being honest with yourself.

13:19And I was telling myself, making a leap forward on the product is the best thing that we can do, but it was just all a lie. I just didn't know what to do. And I thought spending money would be an easier thing to do than to sit back and think about a really wise way to use my resources. Can you really be too lean, spend not enough? At some point, I remember after raising money, we had money in the bank, like seed stage, and because I was at that time living in Paris and I had to travel to SF very often, I would book the worst hotel in the Tenderloin. That was such a bad experience. I wouldn't sleep well.

14:00I was not as good in meetings after that. But I think that was a bad way to save money. I'll give one example of a mistake that I see founders making today where I think they're being penny wise and found foolish, is moving their startup after YC to a city where it's much cheaper to live and much cheaper to hire. I was one of those companies at the time when revenue was not popular, like growth and usage was proper. We were building a mobile messaging app in 2007, 2008, and we were tracking monthly active users and the retention of them. We weren't tracking revenue. We weren't making some amount of small revenue, but the only way that we can compare ourselves to, like, are we doing well is the usage and not the revenue.

14:50So in hindsight, I don't think anyone has this problem today. This is not really a thing that used to track usage. You don't really track revenue. But in hindsight, like, we didn't really know what X number of monthly active users would transform into for more fundraising. The only way for us to continue was to raise more money. And it was kind of unclear, actually. It was not like we were talking to investors and be like, how many millions of monthly active users do you need to get another round? So for us, it was very unclear, I think. Are we spending too much, too low? In hindsight, yep, we were spending too much, I think.

15:20But we didn't have any. People tend to forget how the 2000s compared to today is in terms of the amount of information that's out there of like, today we can ask that question in like 20 minutes. You talk to a bunch of people. At the time, it was unclear. There's a lot of asymmetry between the rounds and investors and founders. And founders weren't that connected with each other. So we're in a much better place today to be able to answer the question. What is the most craziest thing that you've ever seen that founders spend money on? I don't know if it's that crazy, but like sometimes, actually happened a couple of times to me recently, like founders waste the money.

15:53And the first things they are going to do is to hire a branding agency, like 50k or whatever crazy amount of money just to rebrand their company. Like new website, new fancy stuff, just such a waste of money and often just a B2B company that nobody's going to find on their website anyway. It's going to be outbound. I don't have an example but I do have an experience that I've actually experienced multiple times at YC which is the company is I think they're doing pretty well and then I don't hear from them for a year and not hearing from someone who's doing pretty well, it can be an okay sign, but sometimes it's a very bad sign.

16:27And then guess what month I hear from them again? One month before death. And you hear from them, you're like, well, it wasn't actually going well. Then all these things happen. And can you help us this one month left? They made a bunch of mistakes in this one year. All of them made a bunch of mistakes. And we were not aware because we weren't talking to them or they were not updating us or they weren't updating any investors. And it is very sad because most deaths, there's a function of spending money are preventable. If you just catch it early enough, it's preventable. But in order to be preventable, you have to get the diagnosis out early.

16:59So you have to know how things are going and when you're spending the money. And sadly, people are probably not updating investors because they're maybe kind of know deep down that things aren't going well. And if I don't tell them, things will be better somehow. But then we can't help. The main advice I would draw here is that you should be transparent with people on how you're spending money. And you should communicate all these things because we've seen the pattern matching of things that work out and don't work out, but we can only pattern match if we actually have the data. Yeah, this is a very common one, and I've talked about it before, but seeing early stage startups spending money on ads, and there's maybe some clever ways to do it.

17:36It's all very specific on the startup and where they're at and what they're trying to accomplish, but it's just so tempting, and it feels so good to buy some ads and know that you're out there, and maybe you get a customer, maybe you get a customer there, a lead, something like that. But you're really outsourcing your understanding of what's going on and how to even talk to customers. And there's no ad that's going to make you smarter. You don't learn anything when you get a customer from an ad at an early stage. Actually, it's worse than that because it becomes addictive. You spend on ads and so you grow faster.

18:09And then you get that expectation of continuing to grow, even if the fundamentals all of the business don't work. And so you end up spending like, hey, you raise 2 million and then you continue spending because why? Like, hey, I have to show growth to my investors. And like, you know, I don't speak about churn. I don't speak about the things that actually don't go well. And that at some point it's so obvious that the trajectory is going to hit a wall and the only way to continue is to raise money. And at that point, like nobody wants to invest. I have this weird theory that there's like a perniciousness to advertising also in the way that all the digital products work where you set a budget.

18:40It's like you're putting a ceiling on what you think your startup can achieve implicitly just by even engaging in this versus having more of a spirit of like, well, anything could happen today. I'm going to go as hard as I can, whether it's outreach, whether it's shipping stuff. Like inherently, you're locking yourself in to some assumption of like, what's the total good that could come for my startup right now? All ad span is either one or two categories. It's either experimental and small, or it's ROI positive. And then it's a payback time in months, and you know exactly how many months you get the money back and you know that every single month.

19:13Those are the only two categories of ad spends that should exist. Founders that spend a lot on ads early on, also there's this opportunity cost because they miss out on figuring out a capital efficient way of acquiring customers and so that when that money spigot turns off, suddenly they don't know how to do it anymore. I had a company last batch and I started working with them, was joined through, okay, how do you do this? How do you do that? Getting to know them. And the only way that they got customers was through AdWords. And they fought so hard when I pushed them on this and challenged them like, hey, you're missing out on some stuff.

19:46And I asked them to switch off the ads for two weeks and see if they could match the same numbers and through any means necessary. And they ended up finding some really clever ways to scrape government documents and permits and reach out to these people. And now they actually owned some way of finding customers and prospecting that they just weren't even thinking about this because it was so easy to just spend a little bit of money on AdWords. I have this framework around startups versus big companies in that startups are not miniatures of big companies where every single function that exists in the big company exists also in the startup.

20:20In fact, most things that big companies have, there are no equivalent in a small startup. Startups only exist to reach product market fit. Until then, nothing else really matters. Which means most of the things you end up spending money on at a big companies, there is not like a mini spend on that in a small company it just doesn't exist at all when startups get funded every single dollar every single energy effort should go towards trying to find parking what to fit which usually is the two founders or the three founders their computers their apartment and maybe one more engineer who's also probably an engineer that you hire like that's basically it there's like really nothing else that goes into this when i see people making mistakes they're looking towards the bigger companies the enterprises or whatever and they're like well if i had this and this and this and this I am now feeling more validated.

21:08My company is more grown up because it feels like a bigger company. And I have some of these functions that bigger companies have, even though you don't really need it, like an office or ads, or like you have people in departments they don't need. It makes you feel better more than it actually makes any different whatsoever. In fact, it makes things worse because you have to manage these people in roles that aren't really needed yet. It creates a huge distraction and it actually makes you spend all your time on the things that you don't, you can't really have distractions where you're trying to get a program fit.

21:39Like you can't, you can't spend time doing one-on-ones with people that work on other stuff. Like everything needs to go into like trying to get to these things. People spend money when they have money. And typically after a seed run, a lot of companies have a lot more money than they have ever had. Yes. And it just feels natural that I should have an office manager. I should have a really nice big office or maybe two offices or maybe a chief of staff. And there's like all of the things that just like you can look at other companies that are successful and you kind of attach yourself to the things that they have and be like, if I only had these four things, then probably I'm successful too.

22:09But none of it matters and actually makes things worse. And to make it very plain, I think all of us have had this experience where we fund companies and the first, maybe even before the start of the batch, the first couple office hours we have with companies, we're picking up on maybe what aspect of big company life a founding team has latched onto and is already subliminally recreating in some way some attachment that they have that they might even not be aware of. And so there's almost like a pruning that has to happen. We have to help them like release some of these assumptions to really pare it back down to being that single-minded organism.